November 17, 2006

Email exchange with Milton Friedman

My friend Peter
Robinson at the Hoover Institute at Stanford was kind enough to pass along a
copy of my book The
End of Medicine to his colleague, Nobel Laureate and father of free market
thinking, Milton Friedman, who sadly passed away yesterday at the age of 94.

I am delighted to have Andy
Kessler's The End of Medicine. I appreciate his suggesting that you send
me a copy. But one good turn deserves another. If you will let Gloria know the
mailing address for Andy Kessler, she will send him a reprint of my venture
into the medical field published in The Public Interest about two years
ago.

It goes in a very different
direction but it is entirely complementary to Kessler's idea.

Cordially,

Milton

A few days later, I
received a Xerox copy in the mail of a piece by Milton Friedman titled “How to
cure health care”. It is a terrific piece, found here and some of
it discusses Gammon’s Law, best summarized by this:

He observed that in "a bureaucratic system . . . increase in expenditure will be matched by fall in production.
. . . Such systems will act rather like ‘black holes,’ in the economic
universe, simultaneously sucking in resources, and shrinking in terms
of ‘emitted production.’"

Thank you so much for sending your Winter 2001 Public
Interest piece "How to cure health care". I've read it and enjoyed it
and realized that it is very complimentary to my book The End of
Medicine. MSAs
coupled with high deductible catastrophic insurance are inevitable. I
am
convinced I will never see a penny from Medicare (I'm 47). By the time
I am 65, I suspect it will be means tested away from anyone with two
nickels to rub
together.

My view in The End of Medicine (if you can get through the funny stories) is
that Silicon Valley will save the day with
ever cheaper technology. It will be these catastrophic/major medical insurers
that will insist upon early detection tests, once they are cheaper than chronic
care.

I hope you enjoy the book and thank you again for sending your "How to
cure health care" piece.

With admiration,

Andy Kessler

I figured that was
that, and was flattered to have had correspondence from such a great thinker. Then
an email showed up in my in box one afternoon. How exciting to be told one is
wrong in such an elegant way!

Your book is fascinating and I
have learned a great deal from it, but I am also persuaded by it that,
ingenious and appealing as is your proposed end of medicine, it is not the way
in which the medical problem is going to be solved. What your book illustrates so
well is the difference between the kind of market that prevails in ordinary
consumer goods such as automobiles, televisions or what-not and that prevailed
in medicine until World War II, and the kind of market that now exists in the
medical area. The market for automobiles, for TVs and so on is a market in
which the producers deal directly with the consumers or, if indirectly, very
closely, and in which the producers are incentivized to try to improve the
quality and lower the cost of the goods that they are providing. They try to produce
items that the consumer wants enough to pay what it costs to produce them.

In medicine today that is not the
case. Almost no consumer of medical services pays for his own cost. Almost
invariably, a third party pays. The incentives that operate in such a market
are very different than the incentives that operate in the consumer market.

Did you ever hear of the Ford
Motor Company having employees labeled grant-seekers or grant managers? Your
image of spaghetti against the wall is a wonderful image for the kind of market
that is described in this book. It is not a market for health at all; it is not
amarket in which the producer seeks to
determine how much consumers are willing to spend on the item it is selling. It
is a market for getting financed for fancy scientific work. Only a small part
of the money being spent in the industry comes from the consumers of the health
services it provides. Most of it is to support the science and the
experimentation and the throwing of the spaghetti against the wall.

You cannot tell me that that is an
efficient way to generate better health. There are obviously some very able and
very serious people in the business, but they are forced to use the procedures
appropriate to this kind of market in which the ultimate object, better health,
is concealed under a dozen layers of advertising, chicanery and what-not.

To make my point in a different
way, let me sketch an analysis of the operation of two kinds of health markets:
the one before World War II and the one since then. As it happens, progress in
improving health for the total population as measured by expected length of
life at birth proceeded at not far from the same rate before World War II and
after World War II. But before World War II it was accompanied by spendingwhich never accounted for more than 4 or 5 percent of
national income.

After World War II, you had the
extraordinary growth in spending so that spending now comes to something like
15 percent of national income. That is what you would expect when you shift
from a market in which people are spending their own money for themselves to a
market in which they are spending somebody else's money for who knows what.

To be more conjectural, isn't this
what you would expect? You have shifted to a far more expensive mode of
operation in which the really dramatic results are produced by machines or by
drugs and benefit a relatively small fraction of the population. Your plan of
early detection is a very good one and goes in the opposite direction. It would
benefit

most the great bulk of the
population, particularly those who have diseases detected at an early age. It
is not going anywhere because there is no pay off. There is no nest of
companies or industries that are offering early detection because the money
would not come in the main from the patients; it would come from Medicare or
Medicaid. So in the

postwar period the greatest
progress has been for that group of people who are being paid for by the
government. The increase in expected length of life at birth has proceeded
at a lower rate after World War II than before; at age 65, at a higher rate.
Very sensible and that progress has been very expensive, much more expensive
than it was before World

War II.

If we could get the market
straight so that customers were paying for it, I believe you could achieve at
least as great improvements in health at a much lower cost and spread over a
wider fraction of the population, but t is not easy to go from one market to
the other. The market as it has now developed has very strong special fixed
interests who will not give up their special position at all easily. The only
real movement in the right direction has been the introduction of health
savings accounts and their gradual spread. That may start a slow and steady
movement in the right direction but I am not overly optimistic.

In any event thank you for the
pleasure and instruction which I got from your book.

Sincerely yours,

Milton Friedman
Senior Research Fellow
Hoover Institution

I waited about 5 minutes so as not to appear over eager and
then sent this reply:

Second, I couldn't agree with you more that a real market economy is needed in
healthcare and almost none is to be found today (beyond vanity care!). Your
"How to cure health care" chapter and the application of Gammons law
of bureaucratic displacement makes that point very strongly.

But I wonder if our two views are complimentary.

In other words, if the technology for early detection exists, and
because of Silicon Valley, gets cheaper every year, then perhaps
that is the stimulus for your free market approach to healthcare. Or
vice
versa, they go together.

Consumers won't give up their insurance or Medicare because they see the large
expense if they do happen to get sick, have a heart attack, cancer, etc. There
are two moral hazards that already exist: 1) people smoke or become obese
because someone else pays the inevitable hospital bills and 2) once they are
sick, they demand almost infinite spending since they are "covered".
It is their right, the thinking goes. And the healthcare system is incented to
provide as much healthcare as they can, for a fat fee, of course.

We hide the allocation of scarce resources behind phraseology such as “quality
adjusted life years” but at the end of the day, it is allocation. We are
drifting north towards Canada!

Eventually, this has to reach a "breaking point". It wasn't at 4-5%
of national income, as you pointed out, and we still don't seem to be there at
15-16% of GDP we spend today. Perhaps at 20 or 25%, it breaks and then goes one
of two ways: 1) Universal nationalized health care, which much more blatantly
allocates scarce resources via waiting times a la Canada and the UK

Or 2) the American way, we means test it. In fact, it just started. Medicare
just slipped in a 73% surcharge to monthly premiums for those who make over
$200,000. Perhaps this is the price umbrella we need. Odd if it’s just a simple
progressive tax on the wealthy that ends up turning the whole thing around.
Healthcare is one size fits all, there is no price discovery today, hence no
real market. This surcharge might be just the thing to kick it off.

Maybe, just maybe, this is how it plays out:

With huge surcharges, the wealthy realize there is no longer value in Medicare.
They become more willing to pay for their own healthcare spending, directly or
via very high deductible catastrophic insurance and Health Savings Accounts for
tax efficiency or tax neutrality.

But, realizing they have to pay more out of pocket, the rich are incented to
stay healthy in the first place. As new early detection techniques become
affordable for the wealthy directly, it becomes cheaper for them to detect
heart, stroke and cancer early than to pay for expensive treatment later. They
are probably rich because they already understand how markets and price mechanisms
work. The wealthy stay healthy!

And like any good technology, as volume rises, it gets cheaper. Think $2000
cell phones circa 1988 the size of a brick that 100,000 white collar workers
bought and now 1 billion $50 phones the size of a deck of cards are sold each
year. It democratizes usage over time.

Actually, as you move down the wealth curves to the more cost sensitive middle
class, they probably won't be willing to fund their own healthcare unless they
see hard evidence that it might actually be cheaper to stay healthy. No one
gives up the week in Hawaii for early detection unless you can prove it saves them money. Or some new
catastrophic insurance product is invented that demands regular screening in
exchange for discount rates. So this takes some time.

But then, the inevitable class warfare kicks in. How dare we have a system that
favors the wealthy? As the middle class “opts out” of Medicare because the
premiums keep rising, a larger portion of the population enters a market based
system with even more incentives for ever cheaper early detection until the
technology gets cheap enough to be adopted universally, across the income
spectrum. Eventually Blue Cross and Medicare realize it is politically feasible
AND cheaper to detect than to pay later, special fixed interests be damned.

OK, maybe a dream, but ever cheaper technology always plays funny tricks with
existing “stifled” markets, think mainframe computers, regulated telephony,
music retailing, phone based travel agents and on and on. It turned them into
market economies when none were thought possible.

So perhaps a market economy (for the wealthy initially) pulls in early
detection. Or early detection enables a market economy. The chicken or the egg?
Who knows - as long as more chickens are hatched! And all because of a
progressive surcharge, won’t that be bizarre.

All the best,

Andy Kessler

My formal economic training consisted of sleeping through Econ 101 and
20 years of hard knocks on Wall Street. I didn’t expect a reply. But one day, I
received this:

My apologies for being so late in
replying to your instructive letter of September 14.

You are the first one I know of to
suggest that the higher rate for wealthier people under Medicare might be the
entering wedge to a broader market system. Well it might. The wealthy are the customers
for each new innovation that comes along whether it be telephone or television
or what-not so they might as well be the customers for a market system for
medicine. I would not be surprised independently to see a considerable number
of us old folk give up Medicare and move toward really private medicine. As you
know, there are many physicians who have done that, who no longer take Medicare
patients and who operate in the market.

So far as early detection is
concerned, it certainly is complementary with the market system. I have no
doubt that in a true market system we would have much more emphasis on early detection
than we do now. Right now, when the source of the funds is government or
foundations or Warren Buffett, the sophisticated scientific work that you
describe in your book is more appealing to the providers of money than early
detection. However, I think you are right that that will change if the market
changes sufficiently.